THE REPORT - May 2000

Index






Interest Deductions
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The Tax Office has issued a draft ruling concerning interest deductions following two important tax cases. Following Steele’s Case the draft ruling states that the ordinary revenue nature of interest is not altered merely because borrowed funds are used to purchase a capital item. 

Further, it states interest incurred before income is derived will be deductible provided: it is not incurred so long before income is derived that the necessary connection is lost; and it is incurred for an income producing purpose and continuing efforts are made to fulfil that purpose. 

The draft ruling also considers interest incurred after income producing activity has ceased. (For example, a taxpayer who sells a business at a loss may be unable to repay borrowings and will continue to incur interest). The Tax Office considers that the interest will be deductible (after income producing activity has ceased) only if there is no legal entitlement to repay the principal.   





Agreements Spanning GST Commencement 
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Existing agreements spanning 1 July 2000 should be carefully reviewed.

 A supply under an agreement entered into before 8 July 1999 will be GST-free until 1 July 2005 or the first review opportunity (provided the recipient is entitled to full input tax credits). If the recipient is not entitled to full tax input credits, the agreement needs to have been in place prior to 2 December 1998. 

It will be critical to determine whether agreements include a review opportunity. CPI adjustments, changes based on turnover, fixed increments and recoveries of outgoings will not be review opportunities. A general review undertaken prior to 1 July 2000 will only be a review opportunity if the review can take into consideration the imposition of GST. Where the agreement specifies more than one supply, a review opportunity concerning a particular supply does not necessarily impact on other supplies.   





Ralph Option 2 Tax Model
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There appears to be substantial Government support for the Option 2 tax model proposed by the Ralph Committee. Broadly, Option 2 involves the abolition of the current tax concepts of income and deductions. It imposes tax on the net cash received by a business plus the change in the tax value of its assets and liabilities. 

Unrealised gains would typically not be taxed. Although the Government has not officially backed the proposal, it is considering its introduction from as early as 1 July 2001. We will keep you informed of developments.   





Trust Loans
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Beware Under shareholder loan rules, a deemed dividend may arise where a trust with unpaid distributions to a private company makes a loan to a shareholder (or associate) in that company. The deemed dividend would be taxable at marginal rates without franking credits. In a recent draft determination, the Tax Office has suggested that the deemed dividend can never be avoided or reduced by repaying the loan.   



ABN Applications
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Thousands of ABN applications have been refused by the Tax Office, predominantly because applicants have not established that they are carrying on an enterprise. Small businesses in particular can expect close scrutiny of their applications. 

Eligible businesses need to apply for an ABN by 31 May 2000 to ensure registration by 1 July.  From that date there will be a requirement to withhold tax at a rate of 48.5% from payments to (enterprise) taxpayers without an ABN.  

Enterprises without an ABN will not be entitled to register for GST or to claim input tax credits.   





Share Splits
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The Tax Office has finalised its draft ruling concerning the capital gains tax consequences of splitting or consolidating shares into a larger or smaller number of shares. On conversion, there is no disposal and no capital gain on the original shares. In addition, the new shares have the same acquisition date as the original shares. 

The cost base of original post-CGT shares will be apportioned across the converted shares. 





FBT Concession Cap
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The Democrats and Government have agreed to increase the proposed $25,000 cap on FBT concessions for charities to $30,000, and to defer commencement from 1 April 2000, to 1 April 2000. A $17,000 exemption threshold and 1 April 2000 commencement date will be retained for hospitals, in accordance with the original proposal.   



Un-dissected Lump Sum Settlement
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In a recent case the Federal Court held that an undissected lump sum compensation payment of $100 million was a capital gain and not income. The court followed Allsop’s Case which held that an undissected amount of damages received in settlement of revenue and capital claims cannot be income, but instead should be assessed as a capital gain. 

This contrasts with the position of the Tax Office in Taxation Ruling TR 95/35 which states that the taxpayer is required to apportion the compensation. The decision may be of benefit to taxpayers who have capital gains which are exempt from CGT or subject to a 50% discount, or for taxpayers with carry forward capital losses.   





Deduction for Director Fees
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The Full Federal Court recently found in favour of the taxpayer in allowing an offsetting deduction for director’s fees received and paid on to a family company. In this case, the family company carried on a substantial business, in addition to the provision of director’s services. The Court (on appeal) found that it was open to the Administrative Appeals Tribunal to hold that the taxpayer was under a contractual obligation to pay over the fees. The Court rejected the Commissioner’s argument that the arrangement as an income splitting device.   



Personal Services Income
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Under proposed legislation, payments to an entity for services performed by an individual will be assessable income of that individual, unless the entity is carrying on a personal services business. 

For such a business to exist, 80% of income cannot come from one source, and one of several other prescribed tests must be satisfied. If the 80% test is failed, a person may apply to the Tax Office for approval that they are nevertheless carrying on business.     





2000 BUDGET ALERT
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At 7.30p.m. on 9 May 2000 the 2000/01 Federal Budget was handed down.  The Government estimates that there will be a cash surplus of $2.8 billion for 2000/01.   

Tax Overview 

The 2000/01 Federal Budget contained very few new tax changes – it seems that there is more than enough with Tax Reform and GST! However, the Treasurer did reiterate existing legislation and reforms in the Budget papers. 

Entirely new tax changes are minor. Many of the announcements will not be new to you, but may serve as a useful reminder.   Reminder About Tax Cuts The Government has reminded everyone about the personal income tax cuts that will apply from 1 July 2000. 

The new taxable income scales and tax rates will be: 

0 - $6,000 Nil 

$6,001 - $20,000 17% 

$20,001 - $50,000 30% 

$50,001 - $60,000 42% 

$60,000+ 47% 

Companies will also benefit from tax cuts, with the company tax rate reducing to 34% from 1 July 2000 and 30% from 1 July 2001.   

Capital Gains Tax (CGT) on Trust Assets 

The Government reiterated its previous announcement concerning the CGT 50% discount for assets held for more than 12 months and the treatment of assets acquired by trusts before and after 23 December 1999. The position is summarised below. 

Assets acquired by trusts before 24 December 1999 will be eligible for the 50% CGT discount, regardless of when the asset is disposed of. For trust assets acquired after 23 December, 1999, the 50% discount will only apply to disposals before 1 July 2001. 

For disposals after 1 July 2001, the trust will be taxes on the gain at the entity tax rate without the 50% discount.   

East Timor Levy Scrapped

The Government will not proceed with the proposed East Timor levy. The levy was to apply form 1 July 2000 to individuals at the rate of 0.5% on taxable income between $50,000 and $100,000 and at 1% for taxable income over $100,000.   

The Wait Continues on Ralph Option 2

 As expected, the Government did not make any announcement on a range of Ralph Tax Reform recommendations, including the Option 2 cash value approach to calculating taxable income. There are still dozens of Ralph Tax Reform recommendations on which the Government has not commented. This compounds the great uncertainty in current tax reform environment.  

 Losses from Non-commercial Activities From 1 July 2000, individuals will have to satisfy more rigorous tests to offset losses from business activities against other income. The measures target taxpayers with losses from farming and hobby type businesses. The tests are based on, amongst other things, turnover, profitability and the value of real property and other assets involved. 

Losses which are non-deductible may be carried forward until one of these tests is satisfied. Primary producers can continue to offset primary production losses against other income (excluding net capital gains) of less than $40,000.   

ACCC Funding Boosted 

The Government will boost ACCC funding over the next two years to assist with monitoring of compliance with price exploitation rules relating to the introduction of the GST.   

Prepayment Deductions 

Further changes have been announced to prepayment rules. Certain excluded prepayments will be deductible when incurred (subject to the 13 month rule) including those related to: certain types of insurance and interest relating to rental properties, or interest relating to publicly listed securities; certain infrastructure bonds; some binding contractual obligations existing on 11 November 1999; and expenditure connected to certain Tax Office product rulings. 

All other prepayments made from 21 September 1999 to 11 November 1999 will be caught by the previously announced transitional rules, which allowed a capped prepayment deduction for (up to) the next five years. Deductions for prepayments made from 11 November 1999 which are not excluded, or which are made under tax shelter arrangements, must be apportioned over the period to which the prepayment relates. 

Individuals and small business taxpayers will only be affected where the prepayment is made under a tax shelter arrangement.   

Personal Services Income

The new personal services income rules were reiterated in the Budget papers.  From 1 July 2000, payments to an entity for services performed by an individual will be assessable income of that individual unless the entity is carrying on a personal services business.   

New FBT Concession Caps

The Government also reiterated the new FBT concession caps.  From 1 April 2000, public hospitals and not-for-profit hospitals will be subject to a ceiling of $17,000 of (grossed up) fringe benefits per employee per annum. 

To the extent to which the ceiling is exceeded, full FBT will be payable. Other public benevolent institutions and FBT rebateable employers will be subject to a grossed up value ceiling of $30,000 per employee per annum. This limitation will not commence until 1 April 2001.   

Other Minor Measures 

Other minor measures announced include: a $120 one-off GST assistance payment to low income earners who receive no compensation under the tax or social security systems in relation to the New Tax System; the refund of excess imputation credits to certain registered charities and gift-deductible organisations from 1 July 2000; increase in the Medicare levy low income threshold in line with CPI movements; and the removal of income tax exemptions for non-resident sporting clubs, associations and sportspersons for income earned in Australia from 1 July 2000.                                                                            





Important: This is not advice. Clients should not act solely on the basis of the material contained in this Report. Items herein are general comments only and do no constitute or convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of these areas. The Report is issued as a helpful guide to clients and for their private information. Therefore is should be regarded as confidential and not be made available to any person without our prior approval.